Flexible Spending Account vs. Dependent-Care Credit

A couple of tax breaks are available for working parents who pay for child care, but you’ll have to choose one or the other. Is it better to pay for child-care expenses using a flexible spending account or to claim the dependent-care credit on my tax return?

Many people will have that question over the next few months, as they make decisions about their employee benefits for 2014. You may be allowed to set aside up to $5,000 in pretax money for the year in a flexiblespending account for dependent-care expenses. Or you could claim those expenses for the dependent-care credit when you file your 2012 tax return. But you can’t use the same expenses for both tax breaks. Most familieswho have access to a dependent-care flexible spending account at work would be better off running their child-care expenses through the FSA.

Money you set aside in a flexible spending account is not only subtracted from your paycheck before income taxes are calculated, but it also avoids the 7.65% Social Security and Medicare tax. So if you’re in the 15% income-tax bracket, you won’t have to pay the 15% federal tax or the 7.65% Social Security tax, which means that you’ll avoid paying a total of 22.65% in taxes on that money. In that case, contributing the maximum $5,000 to your dependent-care flex plan cuts your tax bill by $1,133. The benefits get even better as your tax bracket rises. If you’re in the 25% bracket, for example, you’ll end up saving 32.65% in taxes on the money you contribute to the FSA — and lowering your tax bill by $1,633. You’ll save even more if your FSA contribution escapes state income taxes.